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Arbitrage crashes and the speed of capital

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  • Mitchell, Mark
  • Pulvino, Todd
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    Abstract

    The imminent failure of prime brokers during the 2008 financial crisis caused a sudden decrease in the leverage afforded hedge funds. This decrease resulted from the asymmetrical payoff to rehypothecation lenders—the ultimate financiers, through prime brokers, to hedge funds. Seemingly long-term debt capital became short-term capital creating a duration mismatch between left-hand side arbitrage opportunities and right-hand side liabilities. Consequently, arbitrageurs became unable to maintain similar prices of similar assets. Mispricing magnitudes, and the time required to correct them, reflect the role of arbitrageurs in maintaining accurate prices during normal times and offer an estimate of discounts at which assets transact during crises.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Financial Economics.

    Volume (Year): 104 (2012)
    Issue (Month): 3 ()
    Pages: 469-490

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    Handle: RePEc:eee:jfinec:v:104:y:2012:i:3:p:469-490

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    Web page: http://www.elsevier.com/locate/inca/505576

    Related research

    Keywords: Arbitrage; Financial crisis; Hedge funds;

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    References

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    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    1. Mark Mitchell & Lasse Heje Pedersen & Todd Pulvino, 2007. "Slow Moving Capital," NBER Working Papers 12877, National Bureau of Economic Research, Inc.
    2. Andrei Shleifer & Robert W. Vishny, 1995. "The Limits of Arbitrage," NBER Working Papers 5167, National Bureau of Economic Research, Inc.
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    5. Bradley, Michael & Brav, Alon & Goldstein, Itay & Jiang, Wei, 2010. "Activist arbitrage: A study of open-ending attempts of closed-end funds," Journal of Financial Economics, Elsevier, vol. 95(1), pages 1-19, January.
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    Cited by:
    1. Jaewon Choi & Or Shachar, 2013. "Did liquidity providers become liquidity seekers?," Staff Reports 650, Federal Reserve Bank of New York.
    2. Lakicevic, Milan & Shachmurove, Yochanan & Vulanovic, Milos, 2013. "Institutional changes of SPACs," EconStor Preprints 68589, ZBW - German National Library of Economics.
    3. Markus K. Brunnermeier & Martin Oehmke, 2012. "Bubbles, Financial Crises, and Systemic Risk," NBER Working Papers 18398, National Bureau of Economic Research, Inc.
    4. Oh, Ji Yeol Jimmy, 2014. "Ambiguity aversion, funding liquidity, and liquidation dynamics," Journal of Financial Markets, Elsevier, vol. 18(C), pages 49-76.
    5. Hanno Lustig, 2013. "A European History Lesson for Today’s Central Bankers," International Journal of Central Banking, International Journal of Central Banking, vol. 9(1), pages 109-120, March.

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